The objective for any investor, regardless of what type of asset they prefer to invest in, is to buy at as low a price as is possible given prevailing market conditions. When it comes to the stock market of today, there seems to be a real shortage of options.
Youâ€™ve all heard the age old maxim about buying low and selling high when it comes to stocks. Of course, that is the main objective no matter if youâ€™re buying stocks, bonds, real estate, art works or collectible cars.
At some point, the investor will likely wish to sell what he holds as investments. When that time will come is anyoneâ€™s guess, of course. The hard part is knowing what the market conditions will be when selling is anticipated. One need only consider todayâ€™s housing market and the troubles facing investors of investment properties.
Who could have known that the market would turn sour so quickly, with some prognosticators telling us now that a true bottom in real estate prices could be years ahead of us? Many flippers and investment buyers of condos and houses look to be stuck with what they bought in the past couple of years.
Of course, any of them who paid more than they should have are learning the hard way that getting caught running with the crowd is usually a bad thing to do if you are an investor with a relatively short holding period in mind before selling. That this particular crowd, real estate flippers, was overly enthusiastic only adds to the woes confronting those hoping to sell soon.
The allure of fast profits encouraged too many to buy high, paying more than the market would pay when the mania died down. So now there is a large crowd who find themselves stuck with what they hold, and monthly carrying costs are eating away at any potential profits to be gained on the sale of their properties. They are truly stuck for now.
To me, that should have been a possibility that more of them should have considered when the excitement of getting rich quick was foremost in mind. Regardless of what type of asset class you prefer to invest in, getting stuck with this or that holding is a very real possibility and selling at a loss is something that few think about at the time of purchase.
To me, getting stuck with a stock is so real a possibility that it is always at the forefront when making any buying decision. Hereâ€™s another old adage that serves me well. â€˜â€™You make your profits when you buy, not when you sellâ€™â€™.
Simply put, if you pay the right price for a house, condo or stock, selling at a profit should be easy regardless of how the markets change over time. In your mind when you get ready to hit the buy button on your computer should be a feeling of relative security that even if the markets turn down, that which you are buying will still hold value to potential buyers.
Paying the right price makes that much easier, obviously. The problem I see today is that there is so little opportunity to buy low in the stock markets. Excessive money printing and deficit spending by fiscal policy makers have allowed so much cash to course its way through the markets in search of profit opportunities that as far as I can tell, virtually everything of value has been picked over, again and again. There seems to be very few rocks yet to be turned over in search of investing profits.
Bargains are as scarce as I can remember them being in the past few years. Investor optimism has inspired too many into the markets with too much money chasing too few value-priced stocks.
So now, one of the more popular rationales being used by stock market promoters is that on a relative basis, stocks are cheap compared to bonds and are better buys. That is surely as wrong as could be, but if itâ€™s all they have left to convince you to pay premium prices for stocks, theyâ€™ll use it.
And thatâ€™s about where we are now in the stock market. You are being asked to buy stocks because they sell at a smaller premium to other assets like bonds. But the reality is that they sell at premiums prices, and buying high is almost always a poor strategy. Just because everything else sells for prices even more removed from their underlying values doesnâ€™t make stocks a buy.
As of today, the S&P 500 is selling at an average price to earnings ratio of about 18. That means that for every dollar of earnings generated by your new holding, you are paying $18. That translates into an earnings yield of about 5.6%.
My question is this; how much risk should an investor accept in the hopes of getting a 5.6% yield in the first year of owning any investment? If you are like me, I donâ€™t think an investor should take much risk at all for that kind of yield. You can get that kind of yield, or close to it, with fixed income options that guarantee youâ€™ll get your original investment back at maturity. Why risk the loss of your principal for such a low yield?
But too few investors look at things this way today. The idea that profits are made by selling at inevitably higher prices at a later time clouds the true nature of investing and puts it more in line with some forms of gambling. We should all consider what our investments will be worth to buyers if the market turns downwards while we are holding out for higher prices.
If you paid the right price for whatever it is that you bought, selling at a profit, or at worst, a small loss should be easily done. It may take longer than anticipated, but getting stuck with an asset whose intrinsic, underlying value is close to what you paid for it isnâ€™t such a bad thing. Think of the home buyer who purchased his home in 2000, before the real estate mania took hold, versus the buyer who got in at the top of the market in 2005.
Certain sections of the country offer plenty of profitable investment opportunities in real estate now, though I think bigger bargains will be there for the taking in 2008. As for stocks, I donâ€™t see much to get excited about anywhere, and that includes my favorite places to invest, that being the international and emerging markets.
The crowd has taken notice of what has worked well and has been plowing into those hot markets for the past year or so. Bargains are as scarce as they have been around the world since the last market peak.
So whatâ€™s an investor to do now? Well, who says that we have to do anything at all? Famed investor Jim Rogers said recently that he has sold out of all of his international and emerging markets holdings, save his investments in China until values reappear.
Warren Buffett sits patiently with somewhere north of $40 billion in cash, waiting it out like he did in the early 1970â€™s while the crowd again ignored the fundamentals of the stock market. Of course, with the dollar getting hammered like it is now, holding a lot of cash doesnâ€™t look so hot either.
If you canâ€™t buy low, donâ€™t buy at all. Instead of sitting on depreciating dollars for what could be months yet, consider allocating some of your savings in traditional inflation hedges like gold, energy and international bonds.
But whatever you do, consider what you will do with whatever it is that you hold on the long side if the market heads south in response to the myriad conditions that argue that it should.
Have a great week.
Bob Wood ChFC, CLU Yusuf Kadiwala. Registered Investment Advisors, KMA, Inc., email@example.com.